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Chapter 16. Determinants of the Money SupplyMoney multiplier Factors that determine multiplier & MS Applications: Great Depression
given problems with simple money multiplier,construct better multiplier cash holdings excess reserves holdings based on M1 = C + D
I. money multiplier how $1 change in MB will affect MS: M = m x MB
1 + c m = rD + e + c rD = required reserve ratioc = ratio of currency to deposits e = ratio of excess reserves to deposits
example rD = .10 C = $400 billion D = $800 billion ER = $.8 billion or $800 million 1 + .5 m = = 2.5 $1 increase in MB, $2.5 increase in M
II. Factors affecting m & MSchanges in rD changes in c changes in e changes in MB
changes in rD higher reserve requirement fewer excess reserves to lendsmaller amount of deposit creation smaller multiplier higher rD
example rD was .10 suppose it rises to .20 1 + .5 m = .20 + .001 + .5
changes in c higher c currency does not expand like depositssmaller amount of deposit creation smaller multiplier higher c
example original example: c = .5 suppose c = .8 1 + .8 m = = 2.00
changes in ER/D higher e banks hold more ER, lend lesssmaller amount of deposit creation smaller multiplier higher e
example original example: e = .001 suppose e = .005 1 + .5 m = = 2.48
what affects e? as interest rates riseopportunity cost of holding ER rise (money could be lent out) ER fall higher i
expected deposit outflowsmust hold more ER
Factors affecting MB MB = MBn + DL MBn is nonborrowed MB-- open market purchase will increase MBn -- open market sale will decrease MBn increase MBn will increase M
DL is discount loans -- increase as banks borrow from the Fed -- increase as spread between market interest rate and discount rate increases
Great Depression 1930-33 big contraction in M1 big increases in c, edepositors withdrew cash banks increase ER due to increase in deposit outflow
as c and e rise, money multiplier declines M1 declines by 25% from
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